Stocks advanced again last week, driven by an improving economic picture and an encouraging earnings season by U.S. companies. But a stronger economy comes with a flip side: less need for monetary stimulus.
Moreover, as I discuss in my new weekly commentary, major central banks are now diverging in their monetary policies, a dynamic we saw vividly on display last week with the Federal Reserve ending its quantitative easing (QE) program, while Japan expanded its version of QE.
As expected, the Fed completed its QE program last week, citing substantial improvement in its labor market outlook and strength in the overall economy, while it deemed low inflation readings transitory. This suggests that the Fed is still likely to begin raising rates next year, probably over the summer. The somewhat more hawkish tone from the Fed had the predictable impact of pushing the dollar higher and gold, which has fallen below $1,200/ounce, lower.
The recent strength in the dollar is not simply a function of a relatively strong U.S. economy, but the relative weakness evident in the rest of the world. With the economies in Japan and Europe struggling, their central banks are being forced to ease monetary policy at the same time the Fed needs to start contemplating raising U.S. rates.